Canada energy

Oil price plunge to leave lasting damage on Canadian economy

March 24th 2020 | Canada | Crude oil

In 2020 the Canadian economy will face twin crises. The recent fall in oil prices, coupled with the novel coronavirus (Covid-19) pandemic, will disrupt the lives of millions of Canadians and pose a stiff challenge to policymakers. The province likely to be hit the hardest is Alberta, the home of the country's oil industry. For all that the Liberal Party federal government has spoken about the need to move away from fossil fuels, oil remains vital to the economy, accounting for about 10% of GDP and 20% of merchandise exports. However, with supply flowing freely and demand shrinking, the industry will need federal support to survive.

It is difficult to imagine a more challenging operating environment for the Albertan economy, which is suffering simultaneous shocks to supply and demand. First, Saudi Arabia declared an oil price war on Russia in early March, after talks on rationing supply between OPEC and its non-OPEC allies fell apart. Saudi Arabia announced that it was to push up oil production from 9.7m barrels/day to 12.3m b/d, and Russia promised an increase of 300,000 b/d, from an estimated 10.8m b/d.

Compounding this abundance of supply is the coronavirus pandemic, which will shrivel demand, both for the one-third of Canada's oil production that is consumed domestically and the two-thirds that are exported. Projecting oil demand in an unprecedented situation is difficult; our latest projection suggests that global oil consumption is likely to fall by 2-3% in 2020. The combination of these twin shocks on the global oil price has been dramatic; dated Brent blend, the global benchmark, fell from US$59/b on February 20th to US$26/b a month later.

An unenviable choice

Canadian oil already trades at a discount to Brent and to the US benchmark, West Texas Intermediate. The Albertan oilsands are located far away from deep-water ports, and so the product has to be transported from the tarsands in Alberta to US refineries on the US Gulf Coast. The nature of Canadian oil production also means that firms cannot adjust the rate of oil production as quickly as producers of lighter oils. These conditions mean that the local industry faces an unenviable choice between keeping production going, losing money on each barrel but being able to restart more quickly when conditions improve, or closing some capacity for longer, saving revenue in the short term but incurring greater costs when the time comes to restart.

The Albertan economy is still in recovery mode from the previous oil shock in 2014. The fall in prices in the middle of that year resulted in provincial real GDP shrinking by 3.7% in 2015 and 3.5% in 2016, and the anaemic pace of the subsequent recovery was such that the economy was still smaller in 2018 than it was in 2014. Unemployment jumped from about 5% in early 2015 to a peak of more than 9% in late 2016 and averaged about 7% in 2019. The provincial budget, which recorded regular surpluses in the 1990s and 2000s and was roughly in balance between the end of the global financial crisis and the 2014 oil shock, has since recorded a string of deficits. In short, the price war and the pandemic have come at a time of provincial economic weakness.

Cap in hand

The oil industry has appealed to the federal government for assistance. This itself is politically undesirable, as the federal administration led by the prime minister, Justin Trudeau, is widely disliked in Alberta for its imposition of a carbon tax and its desire to wean the economy away from fossil fuels. (Mr Trudeau's Liberal Party did not win a single seat in the province at the 2020 federal election.) Nevertheless, the government will be receptive, and a C$15bn (US$10.3bn) support package is on the way. The details remain under wraps, but the package is likely to include cheap loans, especially for small and medium-sized firms, tax holidays, and job-creation schemes for laid-off workers, perhaps involving cleaning up disused facilities. The premier of Alberta, Jason Kenney, has called for the creation of a credit scheme similar to the US's Troubled Asset Relief Programme, which was used to save banks and automotive firms after the financial crisis. This would lead the federal government to buy up shares in struggling companies.

At present, any measures would be welcome for the industry, but neither the supply nor the demand shock is within the federal government's power to control. Our latest forecast assumes that the coronavirus pandemic will have a lasting impact on global output, pushing the global economy into a sharp slowdown (at best) this year. In Canada, as elsewhere, demand for oil will be suppressed by the preventive measures taken to slow the spread of infection, which will limit personal movement and business activity. We expect the Saudi-Russia price war to push up global oil production by about 3% this year. The combination of these two trends suggests that the average Brent price will fall to an average of US$32.1/b this year—a decline of almost 50% compared with 2019. There will be a similar drop in Canadian oil prices, which, coupled with the coronavirus epidemic, will place the Canadian economy under heavy strain.